Why Small Businesses are Worried About Double Taxation

Treasury Secretary Tim Geithner is urging Congress to “revisit” the tax code… and how the code treats small business owners. Amen. It’s about time.

Hong Kong’s tax form is a 3×5 postcard. Surely, if the president’s mandate for this administration is to make the US “the best place on Earth to do business,” Mr. Geithner is envisioning something similar.

Yeah, right.

Here’s the rub: Currently, a small business owner has a choice of paying taxes as a corporation… or alternatively, through a structure like a partnership that makes it possible to report profits and losses on a garden-variety individual 1040.

“Congress,” says Geithner, “has to revisit this basic question about whether it makes sense for us as a country to allow certain businesses to choose whether they’re treated as corporations for tax purposes.”

Here’s what Geithner sees: $3 trillion of income that suddenly would be subject to tax, some of it racked up by big law firms, investment partnerships and so-called S corporations.

Here’s what small business people see: double taxation. They’d have to pay tax first as a corporation, and then again as an individual, as if they were drawing a paycheck from that corporation.

“Most small to midsized businesses in the United States,” explains Neal Weber, a small-business consultant, “are structured as pass-through entities in order to avoid double taxation.”

Kauffman Foundation research finds startup firms to be the “sole engine of job creation” in the US economy. Mr. Geithner, who you’ll recall has trouble with his own tax returns, proposes to throw sand in the gears of this engine. The Senate Finance Committee may take up the matter as early as today.

Addison Wiggin
for The Daily Reckoning